Pound Sterling Forecast: Talk of October Snap General Election Poses Further Downside

Above: Boris Johnson, the favourite to replace Theresa May could soon find he only has a parliamentary majority of 3. File Image © Bundesministerium für Europa, Integration und Äußeres

- Snapshot: GBP/EUR: 1.1144 | GBP/USD: 1.2533

- Conservatives eye October vote

- Analysts see further downside potential in Sterling

- YouGov poll shows four-way race amongst parties

The Pound recorded its ninth consecutive weekly loss against the Euro ahead of the weekend, and it recorded its lowest weekly close against the U.S. Dollar since April 2017.

The weakness extends to the majority of major currencies, as a multi-week sell-off extended amidst a combination of political uncertainty and deteriorating economic data continues to weigh.

For Sterling, it's not just the Brexit deal/'no deal' equation that is injecting confidence-sapping uncertainty into the market: the prospect of a General Election is another factor at play with news that the Conservative party are gearing for a General Election before the year is out. 

This is news that will do little to boost confidence in the UK currency.

The Financial Times reported Friday that "Conservative MPs are spending the summer preparing for a snap general election, claiming that if Boris Johnson becomes prime minister he will either be forced to go the polls or decide to take a gamble to increase his majority."

Even in pre-Brexit times, impending elections did tend to inject uncertainty into the market and contribute to underperformance by Sterling.

The incoming Prime Minister - in all likelihood Boris Johnson - will find he has a wafer-thin parliamentary majority at his disposal.

If the EU refuse to renegotiate the Brexit deal in a substantial manner - as evidenced by incoming European Commission President Ursula von der Leyen's recent comments - then there is a high likelihood Johnson will have to pursue a 'no deal' if he is to deliver on his promise of delivering Brexit by October 31.

But, a number of Conservative Party MPs have warned they would resign from the Party in order to prevent a 'no deal' outcome. This could effectively paralyse government. There is also a chance they could join the opposition and deliver a vote of no-confidence in the Government if this was the only route to preventing a 'no deal'.

Sky News reported Friday that up to 30 Conservative MPs are getting behind Chancellor Philip Hammond to strategise on how they can thwart any 'no deal' Brexit plans promoted by their incoming leader.

And, the Conservative effective majority could be about to become yet smaller with news a pro-Remain agreement has seen a number of parties unite behind a single candidate for the first time at next month’s parliamentary by-election in Brecon & Radnorshire that could well see Conservative incumbent Chris Davies deposed.

Plaid Cymru and the Green Party will not stand in the election with the view of aiding Jane Dodds, the Liberal Democrat leader in Wales, to secure the seat on August 01.

This would leave the Conservatives with a working majority of just three, which is surely unsustainable for a Prime Minister looking to push through the House of Commons perhaps the most important legislation in a generation.

Gillian Keegan, Chichester MP, told the FT: “There’s a scenario [where] an election could be called in early October. There are a lot of people who think there will be an autumn election.” She said she was preparing literature and reviewing her campaign structure."

"With Parliament unable to agree on the next step forward, our economics team believes that the risks of a general election have materially risen," says Kamal Sharma, FX Strategist with Bank of America Merrill Lynch Global Research. Sharma says he sees an election prompting a spike in volatility in the British Pound exchange rate complex.

"A hard Brexit or the prospect of a new election is likely to weaken the GBP further, while a controlled withdrawal or a second referendum is likely to reduce the risk premium on the GBP and strengthen it," says Richard Falkenhäll, Senior Currency Strategist with SEB. "Currently the outcome looks more uncertain as a new Conservative leader could widen the rift between the government and the Parliament further. This suggests that the GBP should fall further in coming months."

Bookmakers Ladbrokes are currently offering odds of 7/2 (a 22% implied probability) that an election will take place in October 2019.

To be sure, neither Labour nor the Conservatives would relish the chance of going to the polls again judging by the latest polling from YouGov that suggests a four-horse race.

"For the first time ever, Labour has fallen into fourth place with just 18% of the vote. The Conservative’s lead on 24%, with the Brexit party on 23%," say YouGov. "Broadly speaking, this is a continuation of the trend we have seen over the past few months of a movement away from two-party politics and towards a fairly even four-way split between Labour, Conservative, Lib Dems and the Brexit Party."

With the Conservatives commanding a thin lead on the Brexit Party it is little wonder Johnson's team have flat-out denied the next Prime Minister would seek another vote to potentially strengthen his hand in parliament.

However, the chaotic state of Parliament combined with the entrenched tribalism on Brexit could well mean he has little choice in the matter.

"It is certainly possible that he might be forced to hold an early election in order to break the deadlock," says Simon Derrick, Chief Currency Strategist with BNY Mellon. "The focus is now shifting towards concerns about significant political uncertainty emerging in September, October and November."

BNY Mellon analysis of currency market options suggests, "it's arguable that it’s not the fear of a hard Brexit that is the prime driver of investor concerns about GBP right now but, rather, uncertainty about the political future in the UK."

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